Teetering or Tottering

Part 1 – Who likes low gas prices?

By John Eichberger | May 2017

Have you ever watched kids playing on a teeter-totter? Who is having more fun – the kid going up or the one going down? Or perhaps more importantly, which kid has greater influence over up vs down? I suggest you could ask the same thing about the oil market – who likes prices going down, who likes them going up and what is having the greatest influence on the movement?

Let’s set the stage – consumers love cheap gas. More than three years of monthly consumer surveys conducted by NACS confirm this – with minimal variation – when prices go down, overall optimism about the nation’s economy goes up and vice versa. At the same time, fuel retailers love cheap gas. Typically, margins are stronger, costs are lower and consumers have more money to spend inside the store. So, these groups want to be on the side of the teeter-totter that is going down.

We also know that when fuel prices are low, consumers are less sensitive. While price remains their number one reason for selecting a fuel retailer, its intensity is much lower than when prices are high. Consequently, consumers don’t shop around for the lowest price with as much dedication, they are not seeking every opportunity to reduce fuel consumption and they are not intensely considering more fuel efficient or alternative fuel vehicles. The impact? Interest in alternative fuels and vehicles wanes.

Those advocating the adoption of alternative fuel, or simply more efficient vehicles prefer it when the teeter totter is up – higher gas prices increase interest in, if not the purchase of, these vehicles. The empirical evidence indicating consumers swapping their preferred class of vehicle in response to volatile pump prices is murky (i.e., Bubba ain’t trading his full size pick-up for a compact sedan and the family with four kids is not ditching their SUV for a two-door coupe), but the adoption of alternative powertrains does seem to flutter with fuel prices.

Let’s use hybrid vehicles as a case study. Since 2013, the retail price of gasoline has dropped from an annual average of $3.49 to $2.13 in 2016. Meanwhile sales of hybrids have dropped 32% and their share of light duty vehicle sales has dropped 40%. This is not a declaration that fuel prices drive the type of vehicles consumers buy – that is way too simplistic. But, it is an indication that consumers are not as easily able to justify paying the additional price for a hybrid vehicle when fuel prices are low – the return on investment takes a lot longer and they simply don’t have a daily reminder to encourage them to do the calculations.

When the retail price of gasoline eclipsed a national average of $4.00 per gallon in 2007, there was tremendous enthusiasm in alternative powertrains and fuels, and investments in research and development flourished as companies raced to satisfy the needs of the frustrated consumer. Now, it seems like you can hit the consumer on the head with a 2x4 and they may not even blink. They are having too much fun riding the teeter-totter down. But if that teeter starts to totter up again, will they start to look around for cost-saving alternatives? And will those alternatives be available and affordable? A lot depends on how long fuel prices stay low, because that impacts how long automobile manufacturers can and will produce products that consumers are not looking for. Particularly in the absence of government mandates, who knows how sustainable it is?

When we start to talk about the government, the dynamics of this old school playground metaphor get interesting. But that discussion will have to wait for my next entry – Teetering or Tottering – Part 2: Balancing oil markets with U.S. policy?

 

Read more from the May Issue of our Fuel for Thought newsletter.